Will G7 Rescue the Dollar?
"Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability." So ended the G7 communiqué taking most of the FX market by surprise with its unusually assertive language. Most traders expected no change in rhetoric from the finance ministers, thus as trading opened up on Sunday night the blunt reference to volatility was likely to exert a toll on

EUR/USD longs who assumed the G7 statement would simply remain static. For most of last week the EZ data surprised to the upside while US data continued to disappoint. The skew allowed the euro bulls to push the pair to all time highs as the decoupling thesis remained in place. But as trading starts this week the G7 statement is likely to turn momentum in favor of the dollar. The key question facing the currency market however, is will the change in G7 attitude be enough to keep the EURUSD from rising beyond the 1.6000 level?

Unfortunately for dollar bulls the US economic calendar this week hold little promise of improvement. Retail Sales are expected to bounce back, but given the poor March results from selected retailers, the possibility of another negative surprise is quite real. Furthermore, the TICs data on Tuesday is expected to print lower as well. In short, if the dollar is to see a sustained rally, traders will need to see some evidence of slowdown in the EZ. For now the G7 statement has provided a temporary boost for the buck, but it will only hold those gains if currency traders starts to see some deterioration in the EZ begin to believe that the decoupling thesis is about to crumble.

Trichet Leaves Rates Unchanged, But Frowns on FX Volatility
The Euro set a fresh all-time high of 1.5915 this week, but failed to break the 1.60 barrier for a third time. Euro bulls bid the pair up before the ECB rate decision, where the central bank left rates unchanged for a the tenth straight month. President Trichet’s subsequent testimony is always a must see for traders. So when the ECB president frowned upon the current volatility in the FX markets, it sent the pair quickly reversing its gains. The remainder of his testimony was typical Trichet rhetoric that inflation remains a concern and the economy isn’t as bad as everyone thinks. Surprisingly, the week’s economic calendar provided support for his case, with German industrial production and investor sentiment both seeing significant rebounds, and German import prices tripling expectations of 0.5% by rising 1.6%.

Trichet’s concerns regarding the currency markets is expected to be a topic of conversation at the upcoming G-7 meetings. Countries like Japan are expected to push for efforts to restore the dollar strength, as it has negatively affected its economy. Leaders are expected to weigh different ideas for providing liquidity to the credit markets and preventing a repeat of the current credit crisis. Regardless of the outcome, the meetings may have a major impact on future price action. The last time the markets thought that there may be an intervention of some sorts, it sent dollar bulls off to the races.

The Euro’s recent failed attempt at breaking 1.600 is strikingly familiar to the resistance the pair encountered at the 1.500 level. The psychological barrier may provide the ultimate resistance, or is the pair one major event from breaking through. The upcoming calendar may provide it in the form of CPI. The inflation gauge is expected to rise to 3.5%, with the core level breaking above the ECB’s 2.0% threshold. As long as the Fed is expected to continue cutting rates and rising inflation prevents the ECB from following suit, the Euro is expected to find support against the dollar. A third straight improvement in Eco Watchers and a surprise in industrial production-which is likely given the rebound in Germany- are other candidates.

Japanese Yen Gains Despite Dismal Economic Data
The Japanese yen managed to eke out gains this week, despite broadly weak data, as unsavory conditions for the carry trade weighed on the USD/JPY and US stock markets on Friday. Taking a look at the Japanese data on hand, given the strength of the Japanese labor markets over the course of 2007, the consumer had been widely expected to make a comeback and help to fuel expansion. However, nothing better demonstrates the exact opposite than the woeful readings of the Eco Watchers survey. This “man-in-the-street” poll recovered slightly to 36.9 from a six-year low of 31.8, but this is still near the lowest levels since the months followed September 11, 2001. The news suggests that Japanese consumer confidence will remain low for the foreseeable future, and does not bode well for already soft spending reports. Meanwhile, the Bank of Japan started out the second quarter with a new Governor, Masaaki Shirakawa, who left rates steady at 0.50 percent last week.

After much political jockeying between the Democratic Party of Japan and the Liberal Democratic Party, former Bank of Japan Executive Director Masaaki Shirakawa – who wasn’t even being considered for the spot a few weeks ago and was initially only approved to serve as a Deputy Governor – was finally nominated by Prime Minister Yasuo Fukuda and approved by the Diet on April 9. Shirakawa, who earned his master’s degree in economics from the University of Chicago when Milton Friedman was a dominant presence at the school, is likely to remain just as focused on price stability as Fukui. However, as the liquidity crunch takes a severe toll on the global financial markets and Japanese inflation appears to be purely the result of volatile food and energy places, the Bank of Japan is now considered to hold a far more dovish lean.

Looking ahead to this week, the Bank of Japan’s meeting minutes and economic releases like industrial production and consumer confidence aren’t likely to shake up USD/JPY. Indeed, traders should keep an eye on the G7 meeting statement, as this could have a resounding impact on volatility in the global forex and equity markets. As Technical Strategist Jamie Saettele mentioned in his Daily Technicals, the risks for USD/JPY remain broadly to the downside so traders should beware of holding on to carry trades.

British Pound Hit Hard on BOE Rate Cut, Dismal Housing Markets
The British pound plummeted this week as the Bank of England cut rates by 25bps to 5.00 percent, though most of the declines came before the decision was even made. Nevertheless, tight credit conditions and a crumbling UK housing sector are proving to be frighteningly similar to the US. While inflation is well above the Bank of England’s 2.0 percent target at 2.5 percent and upside risks remain given the resilience of commodity price gains, the Monetary Policy Committee has little room for maneuver. Despite two 25bp rate cuts since December and continuous efforts to boost liquidity in the money markets, banks remain reluctant to lend. Nationwide and the Royal Bank of Scotland are among some of the banks that have raised mortgage rates in order to deter borrowing and limit exposure to that kind of debt. These restrictive conditions have only added pressure to the deterioration of the UK housing market in a high supply/low demand environment. During the month of March, HBOS house prices dropped 2.5 percent – the sharpest decline since 1992 – while mortgage approvals have dwindled down to 73,000 in February – the lowest since 1995 – from 120,000 in early 2007. The minutes of the Bank of England’s March meeting showed that the MPC thought a “further tightening of credit conditions remained possible” and that “sentiment had deteriorated in the money markets and longer-term credit markets.” With these conditions coming to fruition and exerting significant downside risks for the UK economy as a whole, it’s no wonder the Bank of England cut rates by 25bps to 5.00 percent. However, the sentiment from this meeting isn’t over yet: when the minutes are released in a few weeks, there is a risk that über-doves like David Blanchflower and John Gieve voted for a 50bp reduction, which could weigh on GBP/USD further.

Looking ahead to this week, economic data is expected to show strong in inflation pressures in the economy and resilient labor markets. However, with the status of the UK housing markets a major story right now, sharp drops in the RICS and DCLG house price indexes may draw significant attention. Furthermore, relative to the US dollar, the British pound is nearly a high-yielder, with interest rate differentials still 275bps in Cable’s favor. As a result, a return to risk aversion in the markets could lead the GBP/USD pair to fall lower.

Carry Unwind Slowly Pushing the Swiss Franc Higher
Risk trends were clearly in control of the carry-sensitive Swissie last week; though recent price action may suggest fear has settled until the next major market shock hits the wires. Such a concern is borne from the lack of direction from USDCHF over the past month. Since the pair’s plunge to a record low on March 17th, price action has consolidated into a wedge that is likely to find a technical break sooner rather than later. And, despite the congestive price action of the past week, the top headlines crossing the wires were still producing considerable volatility for risk sentiment and the franc. Trying to establish some level of support for the battered financial markets, two major banks reported success in drawing on market liquidity despite the supposed dire state of credit and lending. Washington Mutual reportedly raised $7 billion from investors only a few weeks after withdrawals doomed Bear Stearns to an emergency bail out. More promising yet was Citigroup’s reported deal to sell $12 billion of its leveraged debt book for 90 cents on the dollar – a modest haircut for a credit crunch in which even liquid assets are difficult to price. However, uncertainty in the outlook for the financial markets would ultimately keep the carry trade weighed down. Starting early in the week, the IMF offered market participants a very frightening number to contemplate. The international lender forecasted losses from the sub-prime spawned market crisis would eventually reach a staggering $945 billion. By Friday, these concerns seemed very plausible after GE (the US economy’s bell weather) reported a 6 percent loss due largely to their inability to sell assets and troubles for their financial business. This is unquestionable evidence that the credit problems are reaching beyond the confines of the global financial sector and reaching into broader economic activity for the world’s largest economies.

Outside the influence of risk sentiment, the franc found little in the way of domestic fundamentals to garner direction from. The only indicator to cross the wires over the period was the government’s labor data for the month of March. According to the numbers, the jobless rate held at a five-and-a-half year low 2.5 percent as economists had expected. This strong trend in employment offers a distinct reflection of the overall health of the Swiss economy: where demand from major export destination the Euro-Zone has kept production and hiring elevated.

Looking over the coming week, fundamentals may have a little more influence over price action; though we shouldn’t expect much. Scheduled for release are the retails sales report and ZEW sentiment survey for February and April respectively. The unique view of consumers’ and investors’ perception of economy activity could guide growth forecasts; but the franc will no doubt see a greater reaction to risk considerations. Earnings season will begin in earnest this week and profit reports from consumer and industrial leaders will reveal whether the credit crunch is actually spreading to the broader economy or the GE incidence was an isolated event.

Canadian Dollar Slides Despite Strong Data and Rising Oil Prices
The sharp drop in USDCAD over the week before last was almost fully retraced through this past Friday’s close. However, despite the steady depreciation in the Canadian currency, fundamentals were largely supportive for the com bloc staple. The activity on the economic calendar could be split into two dominant themes: housing and trade. Housing was covered by three separate indicators. Building permits was the most bearish, falling for the fourth consecutive month (the worst trend for construction plans since 1990). However, there was an upside to this data in that residential filings actually jumped 18.2 through February. Confirming this strength construction activity actually held strong through March. The annual pace of housing starts was little changed over the month against expectations of a sharp drop. Rounding out the checkup on the housing market, the new housing price index revealed consumers were sufficiently capitalized and confident in credit and growth conditions (despite rising global issues that would suggest otherwise) to raise prices for a 14th straight month. The stand alone international merchandise trade report was altogether the most impressive piece of data for loonie traders to digest. Already expecting a modest improvement in the positive gap, the surplus unexpectedly ballooned to a nine-month high $4.9 billion owing largely to a surge in energy and auto exports. Shipments of energy products hit a record and exports to the US grew 3.8 percent – strong readings now, but not likely sustainable for long.

And, outside the convenient confines of the economic docket, even the commodity correlation was failing the loonie. Crude oil – the on again/off again guide for USDCAD price action – extended it rebound to fresh record highs. However, if fundamental FX traders were at all encouraged that rising crude prices would sustain Canadian growth, they weren’t turning their convictions into price action. Looking ahead, it is difficult to judge whether oil will reclaim its influence over the Canadian currency. However, we maintain that it will be very difficult for USDCAD to establish a strong upside trend without crude falling back below $100/barrel. In this commodity’s fickle price, the market can see support for trade, demand for exports and job growth.

Looking for a little more certainty in loonie price action, the economic calendar will produce a few notable economic indicators. The later released leading indicators report for March will look to reverse a very unflattering trend for growth projections. This composite report has projected a contraction in growth one to two quarters three times in the past four months times. Perhaps more accessible for FX traders though may be the consumer inflation data for last month. After the Bank of Canada cut rates 50bp at its last meeting (and considering they’re expected to do so again on the 22nd), traders will want to see whether inflation will be a rally point for dovish restraint. However, both headline and core, annualized figures are expected to slip further below the BoC’s target rate. Consistent, aggressive cuts from the Canadian policy authority would quickly boost the appeal of the oversold US dollar.

Australian Dollar Ignores Data, Pushes Higher
Though hardly aided by economic data, the Australian dollar continued to rally this week as a calming in the markets proved supportive. The AUD is among the high-yielding currencies that have been closely linked with leading equity indices in recent months, selling off sharply during periods of risk aversion. Fundamental metrics released this week lent credence to the RBA’s assertion that monetary tightening had been “substantial” and the economy was well set along a cooling trajectory. Early in the week, we saw February exports dropped by a whopping -4.1%, widening the trade gap by nearly a billion more than was expected. Shipments of mining goods declined sharply as floods disrupted deliveries and cyclones led to closures of oil fields and iron-ore export ports. Imports were largely unchanged, easing a marginal -0.2% having expanded at 5.0% last month. The decline in imports may accelerate as elevated borrowing costs eat at the purchasing power of Australian consumers. March Business Confidence continued to slump, putting in a record third consecutive pessimistic monthly reading. Consumer confidence followed suit, printing at the lowest level since 1993. Employment figures offered a bit of respite from dreary data, marginally outpacing expectations as the economy added 14.8K jobs versus the expected 10K. Seemingly unquenchable Chinese demand for Australia’s mineral export goods has pushed firms to continue hiring all the while borrowings costs climbed higher. This has repeatedly thwarted forecasts by analysts calling for a correction. That said, labor market data tends to lag other indicators in expressing the effects of slowdown. With the Australian economy just starting to turn, an easing in employment seems invariable.

Looking ahead, the coming week will bring little by way of new insights. Wednesday sees the release of the Westpac Leading Index, a broad collection of indicators designed to give a timely view of the economy’s near-term trajectory. January’s reading printed flat at 0.0% and marked the first time that the index fell below the annualized trend growth rate (showing annual expansion at 4.1% versus the 4.2% trend level). The week concludes with the release of first quarter Export Price Index figures on Friday. On balance, these indicators should not dominate AUDUSD trading in the near term. The market has already priced in the prevailing fundamental scenario for Australia. The currency will appreciate should markets remain calm, but price action will become erratic if risk aversion enters the picture once again.

New Zealand Dollar Could Stumble on Risk Aversion
While the past week was very light on New Zealand economic data, those releases that did come across the wires were decidedly negative. Firms’ confidence evaporated as the NZIER Business Opinion Survey showed the lowest reading in 33 years for the first quarter. A net 64% of polled companies stated they expect the economy to contract as record-high interest rates depress the housing market and put the brakes on consumer spending. Echoing this sentiment, the Business NZ Purchasing Manager’s Index showed New Zealand’s manufacturing sector shrank for the first time in 2 years, printing at 48.3 and falling below the “boom-bust” level of 50. With recent reports also indicating that consumer confidence has weakened to the softest reading since 1998, sings abound that a contraction in New Zealand economic growth is broadly underway.

Next week brings Retail Sales figures for February. Considering the current economic climate in the island nation, a positive reading here is highly unlikely. First quarter Consumer Price Index numbers will also be on deck, but their implications are slim if at all relevant in the near term with the RBNZ firmly on hold at 8.25%.

Dire economic news aside, the NZDUSD pairing rallied decisively last week. A calmer tone across markets eased sentiment towards risky assets, catalyzing high-yielding currencies like the NZD and AUD. Should risk appetite continue to remain supported next week, the New Zealand Dollar is likely to ascend higher. On balance, another bout of risk aversion would could send it tumbling again.

Boris Schlossberg is a Senior Currency Strategist at FXCM.